The Renminbi as a Reserve Currency Appears Inevitable

The IMF will decide this 30 days whether to make the Chinese renminbi the 5th international reserve currency. For that euro, that would not be victory or lose game.

Behind the actual facade, there has been much discussion about the inclusion of the Chinese currency – the renminbi (RMB) – as the fifth international reserve currency.  Initially, Beijing hoped that, following the International Monetary Fund’s (IMF) long-anticipated November meeting, the RMB could become part of the international currency basket through 1 January 2016.

After China’s development deceleration, and the boom and modification of its equity markets, the actual Fund’s experts recommended in early August that the IMF would delay its RMB inclusion until Sept 2016.  The IMF meeting will take location at the end of November. What will the choice – whatever it will be – mean towards the euro?

Two-step Review

The basis for the IMF inclusion decision will be on the review of the Special Drawing Right (SDR), that the Fund created in 1969. It is an worldwide reserve asset, which currently includes US dollar, euro, British pound, and Japoneses yen.

China’s first work to have the RMB included in the SDR basket took place at the previous IMF Review in 2010. That attempt failed, because of inadequate capital account convertibility. In the era of president Xi as well as Primer Minister Li, Beijing has made the liberalization of the capital account and the exchange rate a major priority.

The IMF review consists of two steps. The first requires that China is a major trading country. Well, today, China is the world’s largest exporter and second-largest importer, immediately after the US.

However, the IMF also necessitates the RMB to be “freely usable.” China achieved full convertibility of the current accounts already in 1996, however capital account restrictions perform remain.

Nevertheless, reforms have accelerated and the IMF does not necessarily need full convertibility. The Japanese yen had been freely usable already in 1978, two years before Tokyo eliminated its foreign exchange regulates.

The IMF Review’s second step requires a final vote by the IMF board. That is the political and subjective area of the IMF procedure. In practice, the RMB needs a 70 percent majority in the last vote to become a reserve currency.

Financial Repercussions

Recently, exchange rates have seen massive forex movements. Since mid-2014, the euro is down by more than 10 percent. Nevertheless, as Europe’s cyclical recovery has proved weak, the European Central Bank (ECB) recently announced it was missing it’s inflation target and had been considering new stimulus.

The ECB main Mario Draghi shuns euro appreciation. When the euro has threatened to appreciate past $1.15, the ECB has warned of additional quantitative easing (QE). After the IMF’s RMB decision, Draghi will decide the need for more QE.

In this environment, the actual near-term effect of the RMB inclusion within the IMF reserve currency basket would likely be small. It involves the reweighting from the $30 billion SDR basket.  Currently, the US dollar accounts for 42 percent and the euro for Thirty seven percent of the total, whereas the British pound as well as Japanese yen are about 9-11 percent each.

The long-term consequences of the RMB inclusion would be huge.

An IMF endorsement could unleash a massive, though gradual reweighting of the global $12 billion reserve portfolio. Private investors would be likely to follow in the foot prints, especially as China’s capital markets evolve and assets improves.

Let us assume that the IMF reserve currency basket would include the RMB and that it would undergo a reweight.  If, initially, Chinese language currency would be about 10 percent of the total, along with Japanese yen and British pound, then the role of the US buck would be likely to decrease to 38 percent and euro to 34 percent, respectively.

That would unleash 10 percent from the $11.6 trillion of global reserves – more than $1.1 trillion – could flow into RMB assets.

No Win-Lose Game

Some believe that the RMB’s gain will be the euro’s loss. This stance unites those pan-Europeanists, who want much more rapprochements with Washington and less along with Beijing, and those eurosceptics, who mistake self-sufficiency with Fortress Europe.

In actuality, the rise of the RMB is every thing but a win-lose game. From Beijing’s standpoint, a healthy European countries is positive to Chinese exports and direct investment, which is why president Xi recently urged the UK to remain part of the EU.

Second, a healthy euro will support European foreign direct investments as well as exports in China, which is rebalancing towards consumption. Indirectly, the euro’utes strength also ensures that US dollar’s unilateral monopoly in global financial will erode over time.

Third, the effectiveness of the RMB in no way implies that currency advantages will remain in The far east alone. US and Western portfolio managers and individual investors would like to invest much more in China’s growth regions and sectors.

However, the reverse is applicable as well. Chinese institutional investors are eager to diversify risk through internationalizing their portfolios, which nevertheless focus on the mainland.

The RMB inclusion is just a matter of time, as the IMF md Christine Lagarde has acknowledged. Even if The far east misses the cut drop 2015, there is a high likelihood of an interim-meeting review that will grant RMB the actual SDR status before the next scheduled decision in 2020.

Making renminbi a world forex would not be bad for euro is republished with permission from The Distinction Group